The Cost-Cutting Power of Medicare

Peter R. Orszag is a Bloomberg View columnist. He is a vice chairman of investment banking at Lazard. He was President Barack Obama’s director of the Office of Management and Budget from 2009 to 2010 and the director of the Congressional Budget Office from 2007 to 2008.Read More.

The Department of Health and Human Services' action today to set a timetable for moving Medicare away from fee-for-service payments is commendable and timely. Secretary Sylvia Burwell's goals are nice and specific, too: Thirty percent of Medicare’s payments are to be value-based by the end of 2016, and 50 percent by the end of 2018.

Why is this important? Because after years of slow cost growth, health care is reaching a crucial tipping point. In fiscal year 2014, inflation-adjusted Medicare spending per beneficiary actually declined compared with the previous year. Yet the next year or two will determine whether the recent era of slow cost growth becomes the new normal, or instead is reversed.

The consequences are enormous, for everything from the nation’s debt to workers’ take-home pay, and the risk of reverting back to faster cost growth is rising. While Medicare spending itself appears to remain subdued, spending outside Medicare may be going up, anecdotal evidence suggests. This isn't shocking: In commercial insurance, the weak economy played a big part in the slowdown, and as the economy picks up, we should expect Americans to spend more on health care.

The largest hospital system in the nation, for example, reports that admissions are ticking up. Employment growth in the sector has also risen, and that's a useful indicator because labor accounts for such a large part of health-care costs. In 2007 and again in 2008, health-care jobs increased by 2.7 percent. From 2009 to the first half of 2014, they grew just 1.7 percent per year. But in the past three months, the increase jumped back up to 2.8 percent.

Containing these pressures requires sending a strong signal to health-care executives that the era of fee-for-service payment really is over. After all, when we pay for quantity, that’s what we get. And Medicare, the gorilla of health care, is the place to send that message; it's large enough to set norms throughout the sector.

The Barack Obama administration (of which I was once a part) therefore needs to make the shift toward value-based payment permanent by setting a clear timetable with specific goals within Medicare.

The administration has now set those targets. If the U.S. is where Secretary Burwell wants it to be by 2016 and 2018, then by 2020, at least 75 percent of Medicare payments may be assessed in some way other than fee-for-service. This is the ultimate goal that Senator Sheldon Whitehouse, my former colleague Ezekiel Emanuel and I have called for.

To be sure, more needs to be done: The targets have to be hit. And that will require action. Today’s announcement provided no details about the specific steps ahead. Will Medicare move more toward bundled payments for specific episodes of care, or toward accountable-care organizations, through which hospitals and other providers receive one payment for all the care a patient needs during a year? Such details are crucial.

The first step in any worthy project, though, is to set clear goals. We desperately needed them for payment reform. With today’s announcement, the administration has raised the odds that the era of slower growth in health costs will continue.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

Peter R. Orszag is a Bloomberg View columnist. He is a vice chairman of investment banking at Lazard. He was President Barack Obama’s director of the Office of Management and Budget from 2009 to 2010 and the director of the Congressional Budget Office from 2007 to 2008.Read more